PRIVATE BANKING
The Good, the Bad & the Ugly
December 2010 | John Price, Miami
For private bankers, there's nothing more enticing than the prospect of landing a wealthy foreign client, but the client's background and source of funds needs to be carefully analyzed. In many cases, only an enhanced due diligence .
Appearances, as they say, can be deceiving. A brand new car might turn out to be a lemon, while an apparent clunker might actually be a road-worthy speedster. You can’t be sure until you check under the hood and take the car for a spin. So it goes with potential banking clients, too. Wealth is no guarantee of legitimacy. And the bank’s reputation is too sacred to rely on appearances.
In 2009, in the midst of the financial crisis, Kroll conducted enhanced due diligence on two very different individuals in Latin America for two private banking clients. The outcome of those two investigations is very telling of the need to push due diligence assignments to an enhanced level, well beyond examining public records, in most Latin American jurisdictions and, for that matter, in most of the world’s 200-plus countries. Please note that in order to protect the confidentiality of our clients, the private banks, as well as the subjects of the investigations, it is necessary to fictionalize the following case studies.
The apparently Good
Kroll was approached by one bank in regard to a very wealthy individual who had shown up, without a referral, asking to deposit more than $100 million. His documents all appeared to be in order and a perfunctory online search of this individual and his companies revealed what appeared to be a plausibly legitimate network of several enterprises, dotted across portions of Latin America and Europe. The bank then turned to World Check and other global databases and found no record of this individual in any databases that flag money launderers or terrorist financiers. So far, so good. The new potential client also showed the bank that he was half way through the application and approval process for an investor-immigrant visa in a respected jurisdiction known for its rigorous background checks. The commercial team at the bank was ready to welcome the new client with open arms. The compliance department was uneasy about the country of origin of the client’s wealth, the great speed at which he had accumulated his wealth and the fact that he came knocking on their door, a respected bank to be sure, but one with little brand recognition in Latin America. The compliance team insisted on conducting enhanced due diligence.
Our initial review of the most fundamental public records in the subject’s country of origin revealed no criminal record of any kind, no litigation history, no tax violations, and no breach of compliance with any of the important regulators. Such a perfect record seemed too good to be true, particularly in Latin America where regulations tend to be onerous. A deeper level of investigation, which involved speaking with regulators and reliable sources inside some of the enforcement agencies, made it clear that the subject had used his political connections to expunge what was a fairly dense and damning history of criminal and irregular behavior. Human intelligence sources in three countries corroborated what appeared to be an elaborate money laundering scheme through a vast array of corporations and accounts across five countries and three continents.
Our report proved to be shocking reading, not least to our client. Kroll is careful not to recommend to its clients whether they should conduct business with the subjects of our investigations. Our role is to help our clients make their own better informed decisions. That said, we learned later that the bank decided to decline the hefty deposit from the subject of the investigation. It was a bitter pill to swallow for the commercial department, who had landed the potential client. However, prudent minds at the bank were redeemed less than six months later when the subject in question was indicted in his home country for a number of serious crimes including fraud.
The apparently Bad
A few months later, another private bank customer of Kroll’s approached our office in a conundrum. They had been referred a new potential customer from an upstanding client of theirs, who promised that this new customer was an honest and forthright successful businessman, who needed to get his money out of the country and was looking for private banking support. However, an initial Google search of the subject’s name by the private bank showed that the person was the prime suspect of a serious criminal offense. So heinous was his supposed crime that the private bank account manager barely mustered the courage to bring it to the attention of the compliance department. He only did so because his longstanding client insisted that the subject was the victim of false, politically charged allegations.
Kroll was hired to conduct an enhanced due diligence of the individual. After speaking with peers of the subject as well as trustworthy sources within the government and judicial communities of the country in question, we discovered that, indeed, the subject was the target of a carefully engineered plot by the government to defame him and seize control of his family’s company. The government had leaked rumors of his apparent malfeasance to cooperative press, but no indictment had been made. The person in question was highly respected in his industry and his family’s wealth had been amassed over several generations though legitimate means.
Our client, the private bank, did eventually accept the subject of our investigation as a new customer. He deposited over $50 million dollars.
Lessons learned
The obvious lesson learned is that the regular tools used to evaluate the reputational risk of new customers in most OECD countries do not suffice in places like Latin America (or the Middle East, most of Asia and Africa). In these developing markets, public records are often incomplete and may be manipulated, the press can be unprofessional, if not unethical, and global watch-dog databases mostly fail to penetrate. Only by conducting enhanced due diligence can a private banker, lender or investor begin to truly understand the reputational risks of a new potential customer. Enhanced due diligence can not only help prevent bankers from taking on high-risk clients, it can also help uncover those diamonds in the rough that are overlooked by less diligent competitors.
For bankers who must weigh the pressures of revenue growth versus ever stricter compliance procedures, managing their customer portfolios is a constant challenge. That challenge is made all the more difficult when managed through large teams of account managers, who are incentivized to bring in new customers, and compliance and legal professionals, who live only by the stick, not the carrot. More and more banks are designing their own risk management matrix to help their sales team and in-market brokers quickly determine which customers can be admitted with a simple background check and which ones require enhanced due diligence.
Below is an example of a hypothetical matrix used in the private banking industry to help their teams decide when to upgrade a background check to enhanced due diligence.
What is Enhanced Due Diligence?
Once the decision is made to embark on an enhanced due diligence of a subject, the private bank must then decide what level of information it needs to feel comfortable and how best to obtain the information. What constitutes enhanced due diligence is the biggest challenge financial institutions face. Enhanced due diligence is not internationally defined. As a result, financial institutions risk being held to differing standards dependent upon their jurisdiction and regulatory environment. An article published by Peter Warrack in the July 2006 edition of ACAMS Today (Association of Certified Anti-Money Laundering Specialists) suggests the following definition of enhanced due diligence:
“A rigorous and robust process of investigation over and above standard KYC procedures, that seeks with reasonable assurance to verify and validate the customer’s identity; understand and test the customer’s profile, business and account activity; identify relevant adverse information and risk assess the potential for money laundering and/or terrorist financing to support actionable decisions to mitigate against financial, regulatory and reputational risk and ensure regulatory compliance.”
Basic due diligence, or background checks, can be conducted internally with the use of subscription tools. Such a level of scrutiny is suitable for almost all US customers and low-risk Latin American customers. Enhanced due diligence, by comparison, requires investigative skills placed in the country of origin of wealth and a level of objectivity that only third-party providers can supply. Most private bankers consider enhanced due diligence to be essential for medium to high-risk Latin American private wealth customers.
Enhanced due diligence is, with few exceptions, an outsourced function for financial institutions. The investigative skills required to properly conduct enhanced due diligence can rarely be sourced from within a bank. The most essential information can only be researched in the jurisdiction(s) pertinent to the new banking customer and few, if any, banks can place investigative skills in all the jurisdictions of their potential client base.
The reliance on primary or human intelligence to conduct enhanced due diligence, the complications associated with investigating wealthy subjects in less than transparent environments, and the relatively small pool of service providers who can provide global coverage are all factors that drive up the cost of an enhanced due diligence, typically to a range of $12,000 - $25,000 per subject and sometimes more. Private banks must therefore weigh seriously the upside benefits of a new client before justifying such an investment. What no US-based banking operation can afford to do is avoid conducting enhanced due diligence if they are to take on a new customer from a foreign jurisdiction. According to the USAPATRIOT Act:
MINIMUM STANDARDS FOR PRIVATE BANKING ACCOUNTS
If a private banking account is requested or maintained by, or on behalf of, a non-United States person, then the due diligence policies, procedures, and controls required under paragraph (1) shall, at a minimum, ensure that the financial institution takes reasonable steps:
(A) to ascertain the identity of the nominal and beneficial owners of, and the source of funds deposited into, such account as needed to guard against money laundering and report any suspicious transactions under subsection (g); and
(B) to conduct enhanced scrutiny of any such account that is requested or maintained by, or on behalf of, a senior foreign political figure, or any immediate family member or close associate of a senior foreign political figure that is reasonably designed to detect and report transactions that may involve the proceeds of foreign corruption.
The rules apply to accounts with aggregate deposits over $1 million. Some private banks will not bother to receive customers unable to deposit less than $10 million, precisely to help afford the significant start-up costs associated with complying with enhanced due diligence requirements. Most private banks, however, lower their entry threshold well below that level. Those bankers must carefully manage their risk (usually through a risk matrix guide) to determine which new client candidates merit the investment of enhanced due diligence. Following a sensible risk matrix guide and outsourcing to competent providers, enhanced due diligence, when needed, goes a long way to helping banks avoid taking on undesirable new customers.
The Author: John Price (
This e-mail address is being protected from spambots. You need JavaScript enabled to view it
) is Managing Director of Business Intelligence at Kroll and a leading case manager on transactional due diligence, competitive intelligence and political risk investigations throughout Latin America.
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